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Analytics, 04 June 2020

Current stock market surge: a trend or correction?

The coronavirus pandemic has had a devastating impact across the world, killing over 380, 000 people and sending the global economy into a recession. Though the crisis has ended a historic stock market bull run that lasted over a decade, the stock market has seen a hype of activity in recent weeks.

The surge in the stock market is not unique, even if the rally has lifted markets in a remarkably short period. Past bear markets have seen stock market bounces of similar magnitudes, and historical bear market rallies can last for long periods, some up to two years. So, is the stock market rally of today a bear market rally, or are we seeing a full recovery? How long might it last, and what are the implications?

Bear markets and bear rallies

A bear market occurs when the stock market experiences a 20% after an all-time high period while a bear market rally is a period during a bear market when stock prices bounce higher before reversing and heading back to fresh lows.

Bear market rallies are often characterized by a sense of hope that markets are heading back toward their highs, signaling a recovery and potentially a new bull market. During a bear market, stocks experience an upward trend that occurs over and over again before a breakthrough that leads to a fresh bull market.

The U.S. stock market has had its fair share of bear market rallies. Since the Great Depression which was caused by the 1929 market crash, the S&P 500, and other indexes have seen 14 separate bear market rallies. In recent years, there have been five bear market rallies since the year 2000, according to Bloomberg’s calculations.

But bear markets are deceitful, as they can be long-lasting. The rallies can go on for weeks or months before the market goes south again and bottom’s out. According to Bloomberg, bear market rallies since the end of 1927 have lasted an average of 627 days before indexes dropped lower and bottomed out. By Bloomberg’s count, the longest was 1,616 days, and the shortest was 133 days.

During a bear market rally, investors can easily make a false sense that markets are recovering from a harsh blowout when they are not. And then they crash again.

Is the stock market experiencing a bear rally?

The early stages of COVID-19 had a severe impact on the stock market. Things started getting worse in February but accelerated in March when states began shutting down their economies. By March 12, the Dow Jones Industrial Average (DJIA) and S&P 500 officially entered the bear market territory, as they both lost more than 25% of their all-time highs in February.

The bear market has remained since then. Since late March, there’s been an immense amount of volatility in markets. Stocks have rallied by more than 20%, driven by the economic stimulus policies put in place by governments to rescue the economy from the effects of the pandemic. For example, the Federal Reserve’s more than $2 trillion stimulus package. Positive news from researchers working on a vaccine for Covid-19 has also added confidence.

Last week, the market was boosted by the European Commission’s proposed $826 billion stimulus package, the largest stimulus package in European history. As the pandemic crisis stalled economic activities across the world, stocks have also been rising on hopes of economic recovery as states start to gradually ease restrictions.

But will the rally sustain?

While the recent stock market bounce has left the impression that markets are recovering and heading back to February highs, experts have warned that the bear market could last longer.

Many analysts and traders have warned that the gains may be temporary. In a survey by the Bank of America Global Research, 68% of global fund managers agree that we’re experiencing a bear market rally—not a recovery. Many of the polled analysts feel we are not free of the bear market yet, drawing from history – past cycles, how markets and economies have behaved in the past.

Some experts argue that an increase in day trading due to commission-free trading, stimulus checks, and the sole fact that many people, for instance, Americans, have more time on their hands as they’re locked down at home are contributing to the recent comebacks in the stock market. Others worry that without another federal stimulus package, the market will soon “sputter out”. Thus the same analysts also believe that the interventions such as stimulus packages may not be enough to take the stock market to its pre-COVID-19 levels. The market has been riding on a handful of stocks, mostly in the technology sector. These stocks - for example, in the entertainment and communications industry - have been useful in keeping people connected and working from home during lockdowns and have been pushing the rallies forward.

Consumer sectors like retail and travel haven’t been adding much due to lockdown restrictions. As such, the rally is narrow and unsustainable. A truly sustainable market has broad participation. The U.S. market, for example, is skewed, and the stock market reaction does not reflect the real economy as more than 40 million Americans have filed for unemployment since the pandemic began. Indeed, recent moves in safe-haven stocks (such as the gold rally) indicate that most investors feel the current rally is unsustainable.

How to invest during a bear market rally?

Bear market rallies are mostly driven by emotional investors. Seeing the stock market crash, many of these investors are tempted to sell before they incur further losses. Once they see the market spike higher, they again feel the need to get back to the game, in worry of missing out on some profits.

The bottom line is that bear market rallies always occur during low economic times. But our investment decisions shouldn’t be driven by them. Emotional reactions to short-term market moves is a dangerous approach that investors should work to avoid. While emotional reactions will want us trying to get back into the market to recoup what we have already lost, it’s not a good strategy to try to recoup past bad decisions.

Investors need not alter their investment strategies due to a false sense of market recovery. Instead, investors should take time to assess their portfolios and determine how much risk they’re ready for. Risk profiles should change as individuals grow older and get closer to their financial goals—they should not change depending on the whims of the market.

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